Interbank rates up on ECB rate view, thin liquidity

Benchmark euro-priced interbank lending rates edged up on Thursday on dwindling excess liquidity and as the prospect of an interim aid deal for Greece supported bets the European Central Bank will hike rates in July. An escalation in the eurozone sovereign debt crisis over the past three weeks had forced markets to trim expectations of how aggressively the ECB would tighten monetary policy, with the Eonia curve showing a 70 to 90 percent probability of a July rate hike only a week ago.
Signs that Greece could get the money it needs to avert a default in July could pave the way for the ECB to signal more tightening when it meets on July 9 although some analysts said a run of soft US and eurozone data could curtail further hikes. "A new aid package for Greece should be interpreted as `freeing the ECB's hand' to some degree. We still expect the ECB to outline its next rate hike in July in next week's press conference," said Norbert Aul, European rates strategist at RBC.
London interbank offered rates for three-month euros were fixed up at 1.38313 percent from 1.38188 percent on Wednesday. Equivalent Euribor rates also inched up with excess liquidity falling to 5 billion euros from 19 billion euros last week. In contrast, three-month dollar Libor rates were set lower at 0.25200 percent from 0.25288 as a run of dour US data prompted speculation the economy may need more stimulus after the Federal Reserve's second quantitative easing ends this month.
Money markets are also betting that the ECB will have to extend its unlimited provision of three-month funds to support Greek, Portuguese and Irish banks still shut out of the interbank market. Moody's delivered another blow to Greece late on Wednesday, downgrading its sovereign ratings futher into junk territory.
Ratings of 18 billion euros of Greek covered bonds were likely to be moved below investment grade and Barclays Capital strategists estimate only 1.5 billion were placed with investors, implying the rest was used as ECB collateral. Two billion euros worth of the paper used as collateral is rated by Moody's and may lose its repo eligibility after the downgrade. The remaining 14.5 billion euros is rated by Fitch, Barclays says.